Community Development Block Grant-Funded Business Development Loan Program

OFFICE OF AUDIT REGION 3 PHILADELPHIA, PA Luzerne County Office of Community Development, Wilkes-Barre, PA Community Development Block Grant-Funded Business Development Loan Program 2013-PH-1001 DRAFT FOR DISCUSSION AND COMMENT ONLY SUBJECT TO REVIEW AND OCTOBER REVISION 31, 2012

Issue Date: October 31, 2012 Audit Report Number: 2013-PH-1001 TO: FROM: Nadab O. Bynum, Director, Office of Community Planning and Development, Philadelphia Regional Office, 3AD //signed// John P. Buck, Regional Inspector General for Audit, Philadelphia Region, 3AGA SUBJECT: Luzerne County, PA, Did Not Properly Evaluate, Underwrite, and Monitor a High-Risk Loan Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector General s (OIG), final results of our review of Luzerne County, PA s $6 million loan of Community Development Block Grant funds to CityVest to revitalize the historic Hotel Sterling and surrounding properties. HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on recommended corrective actions. For each recommendation without a management decision, please respond and provide status reports in accordance with the HUD Handbook. Please furnish us copies of any correspondence or directives issued because of the audit. The Inspector General Act, Title 5 United States Code, section 8L, requires that OIG post its publicly available reports on the OIG Web site. Accordingly, this report will be posted at http://www.hudoig.gov. If you have any questions or comments about this report, please do not hesitate to call me at 215-430-6729.

October 31, 2012 Luzerne County, PA, Did Not Properly Evaluate, Underwrite, and Monitor a High-Risk Loan Highlights Audit Report 2013-PH-1001 What We Audited and Why What We Found We audited Luzerne County s $6 million loan of Community Development Block Grant funds to CityVest that was expected to be used to revitalize the historic Hotel Sterling and surrounding properties. We did the audit because HUD Office of Inspector General (OIG) audit report 2012-PH- 0001 1 identified this long standing open Block Grant activity and because we received a citizen complaint alleging possible misappropriation of these funds. Our objective was to determine whether the County properly evaluated and underwrote its loan to CityVest and whether the project met its designated national objective. What We Recommend We recommend that HUD require the County to reimburse its business development loan program $6 million from non-federal funds for the ineligible expenditures related to the Hotel Sterling project and that it require the County to develop and implement comprehensive procedures for evaluating, underwriting and monitoring proposed projects. The County did not properly evaluate, underwrite, and monitor its loan to CityVest. After nearly 10 years and $6 million expended, the project won t meet its designated national objective of job creation. The County and the City of Wilkes-Barre plan to demolish the hotel and clear the site although no permanent jobs were ever created. Therefore, the $6 million in Block Grant funds expended for this project is an ineligible expenditure of taxpayer dollars. CityVest also used HUD funds inappropriately to make an unreasonable and unnecessary expenditure of $303,000 to satisfy two municipal liens against a property that it had purchased. It was the responsibility of the former property owner to satisfy the liens. 1 HUD Needed To Improve Its Use of Its Integrated Disbursement and Information System To Oversee Its Community Development Block Grant Program, dated October 31, 2011

TABLE OF CONTENTS Background and Objective 3 Results of Audit Finding: The County Did Not Properly Evaluate, Underwrite, and Monitor 4 a High-Risk Loan Scope and Methodology 16 Internal Controls 17 Appendixes A. Schedule of Questioned Costs 19 B. Auditee Comments and OIG s Evaluation 20 C. Project Budget From Loan Application 32 D. Project Budget From Loan Agreement 33 E. Project Budget From Amended Loan Agreement 34 F. CityVest Expenditure Summary 35 2

BACKGROUND AND OBJECTIVE Luzerne County, PA, is a Community Development Block Grant entitlement grantee. The U.S. Department of Housing and Urban Development (HUD) annually awards grants to entitlement grantees to carry out a wide range of community development activities directed toward revitalizing neighborhoods, economic development, and providing improved community facilities and services. The County consists of 76 municipalities, governed by a three-member board of commissioners. It manages its community development programs through its Office of Community Development located at 54 West Union Street, Wilkes-Barre, PA. The executive director of the Office of Community Development is Mr. Andrew D. Reilly. The County s Business Development Loan Program is an economic development tool, funded by HUD s Community Development Block Grant program. The primary objective of the loan program is to stimulate economic growth in Luzerne County by providing financial incentives leading to the creation of new businesses or the expansion of existing businesses in the County, creating new employment opportunities and strengthening existing jobs, stabilizing or increasing the tax base, and increasing private investment. The County s board of commissioners, through the County s Office of Community Development, is responsible for the development, administration, implementation, monitoring, and evaluation of the loan program. The loan program provides low-interest financing to firms carrying out eligible economic development type projects meeting program objectives. CityVest is a not-for-profit community development corporation, based in Wilkes-Barre, PA. Its mission is to undertake housing and commercial development projects to advance the economic revitalization of northeastern Pennsylvania s Wyoming Valley, particularly the downtown urban centers of Wilkes-Barre, Nanticoke, and Pittston. CityVest was founded in September 2000. In September 2011, its board of directors considered dissolving the organization. Board meeting minutes indicated that it did not dissolve at the urging of the County s board of commissioners. On October 2, 2002, CityVest submitted an application to the County requesting a loan of $4 million to revitalize the Hotel Sterling site, located in Wilkes-Barre, PA, including the surrounding properties. The County entered into a $4 million, 20-year loan agreement with CityVest on November 6, 2002. The agreement required CityVest to create 150 permanent fulltime-equivalent jobs with 80 of those jobs benefiting low- and moderate-income persons. In September 2006, CityVest requested an additional $2 million loan for the project. On March 22, 2007, the County amended its loan agreement with CityVest and provided an additional $2 million for the project. The revised agreement required CityVest to increase the number of permanent full-time-equivalent jobs to 175 and the number of those jobs benefiting low- and moderate-income persons to 90. Our objective was to determine whether the County properly evaluated and underwrote its loan to CityVest and whether the project met its designated national objective. 3

RESULTS OF AUDIT Finding: The County Did Not Properly Evaluate, Underwrite, and Monitor a High-Risk Loan The County did not properly evaluate and underwrite its loan of $6 million to CityVest. The project won t meet its job creation national objective. This condition occurred because the County lacked comprehensive procedures for evaluating and underwriting proposed projects before approving business development loans and did not properly monitor the project. The County s lack of objective evaluation and underwriting of the project and its lack of proper project monitoring contributed to $6 million in Block Grant funds being spent on an incomplete project that failed to achieve its job creation national objective. The County believed its evaluation and monitoring procedures were sufficient. Since the project won t meet its designated national program objective, the related funds were ineligible program expenditures. The County Was Responsible for Evaluating and Underwriting the Loan The County was responsible for properly evaluating and underwriting its $6 million loan to CityVest. HUD regulations at 24 CFR (Code of Federal Regulations) 570.209(a) provide the County guidelines designed to provide a framework for financially underwriting and selecting Block Grant-assisted economic development projects that are financially viable and will make the most effective use of Block Grant funds. The objectives of the underwriting guidelines include ensuring that project costs are reasonable; all sources of project financing are committed; the project is financially feasible; and to the extent practicable, Block Grant funds are disbursed on a pro rata basis with other finances provided to the project. However, the County s policies and procedures for evaluating and underwriting its Block Grant loans consisted solely of a single-page checklist that failed to adequately cover key HUD guidelines. HUD s underwriting guidelines recognized that different levels of review may be appropriate to take into account the size and scope of a proposed project. Although the HUD guidelines for evaluating project costs and financial requirements are not mandatory, HUD expects recipients to properly evaluate and underwrite these loans. HUD expects recipients, when they develop their own programs and underwriting criteria, to take these factors into account. 4

Given that the $6 million loan the County made to CityVest was by far the largest loan in its business development loan portfolio, 2 it was reasonable to expect the County to have conducted more than a cursory level of evaluation and underwriting before making the loan. The County Approved the Loan Although the Project Lacked a Plan In the description of the proposed project in its October 2, 2002, loan application, CityVest stated that the exact future usage of the Hotel Sterling is unknown. CityVest intends to seek developers to assist and/or operate the site at a later date. Despite these statements, the County entered into a $4 million loan agreement with CityVest on November 6, 2002, or 35 days later. The County Did Not Ensure That Other Project Funds Were Committed to the Project The County did not ensure that all needed sources of project funding were committed at the time the loan agreement was signed. CityVest s October 2, 2002, loan application showed that the budget for the project included the developer s equity of $850,000 and $3.2 million in funds from other sources (see appendix C). A footnote at the bottom of the page stated that CityVest intended to seek funding from at least five other Federal and State sources. However, the same footnote also stated, CityVest has not received approval for any of this funding yet. The audit evidence showed, however, that CityVest never applied for $2.2 million of the $3.2 million it reportedly expected to obtain from other sources to complete the project. In the November 6, 2002, loan agreement, 35 days after CityVest applied for the loan, the budget for the project again included the developer s equity of $850,000 3 and $3.2 million in funds from other sources (see appendix D). However, at the bottom of the page were five footnotes indicating that the sources of other funds were HUD, the U.S. Department of Commerce, the U.S. Economic Development Administration, the U.S. Environmental Protection Agency, and the Pennsylvania Department of Community and Economic Development. The County had documentation to demonstrate that CityVest received a $1 million grant from HUD for the project at the time the loan agreement was signed. However, the grant was to be used for the Hotel Sterling project and another 2 The County s Business Development Loan Program portfolio as of February 29, 2012, consisted of 61 loans. There were 37 loans of $500,000 or less, 10 loans between $500,000 and $1 million, 13 loans between $1 million and $3.6 million, and 1 loan that was greater than $3.6 million the $6 million loan to CityVest. 3 Loan agreement exhibits A and B made CityVest responsible for the developer s equity of $850,000. 5

project. The grant agreement did not indicate the amount of funds CityVest would use for each project. Lastly, the County s Business Development Loan Program Handbook stated that the program was intended to finance projects that would have a positive impact on the County by leveraging a significant amount of private investment. 4 However, the planned financing for this project did not include private funds, although the president and chief executive officer of Guaranty Bank was a member of CityVest s board of directors. The County Did Not Properly Assess the Feasibility of the Project and Evaluate the Project s Costs The County alleged that a feasibility study for the project was performed in 2001 to support its evaluation of the project and its costs. The nine-page document, dated June 15, 2001, and labeled a feasibility study, contained five pages of photographs and drawings of the project site and a page providing information on the physical location of the project site and background on CityVest. Although the remaining three pages were numbered, the pages were labeled sample budget scenario for site considerations; project construction components; and soft costs and summaries. All three pages were marked DRAFT in bold letters. This nine-page document did not constitute a valid feasibility study because, as stated in its October 2002 loan application, CityVest did not know the exact future use of the Hotel Sterling. Without knowing the exact future use of the site, there were no valid, detailed project costs to be reviewed. Moreover, CityVest paid for this study. There was no evidence that the County performed an independent evaluation to assess the prospects for the project s success. It was not clear what CityVest intended to do with the loan funds. The County s policies and procedures for its business development loan program included a single-page financial analysis checklist for evaluating loans. The County believed its evaluation procedures were sufficient. The County completed this form for the CityVest loan. However, the form did not provide sufficient evidence that the County performed a detailed evaluation of the project costs. The County marked 7 of the 10 checklist factors N/A. It marked the other three factors affirmatively, indicating that it had obtained cashflow statements, examined the proposed costs, and tested for reasonableness of the costs. However, there was no cashflow statement in the County s files and no documentation to demonstrate that it had examined and tested the reasonableness of the costs. The only document attached to the checklist was a simple spreadsheet showing a project square footage and cost summary over two phases 4 Leveraging a significant amount of private investment was the first of three impacts listed in the handbook. 6

for the project and a list of funding sources for the first phase. The list of funding sources totaled nearly $22.4 million, including $13 million in private funding. However, as stated above, the exact future use of the Hotel Sterling was unknown, and the financing for this project, as disclosed in the loan agreement, did not include private funds. Therefore, the relevance of the data on the spreadsheet was dubious. The Project Did Not Comply With HUD s Jurisdiction Requirements The County did not have documentation in its files to demonstrate that it complied with jurisdiction requirements before or after making its loan to CityVest. The regulations at 24 CFR 570.309 state that Block Grant funds may assist an activity outside the jurisdiction of the grantee only if the grantee determines that such an activity is necessary to further the purposes of the Housing and Community Development Act of 1974 and the recipient s community development objectives and that reasonable benefits from the activity will accrue to residents within the jurisdiction of the grantee. The regulations also require the grantee to document the basis for such determination before providing Block Grant funds for the activity. In this case, the County was the grantee, and the City of Wilkes-Barre (also an entitlement grantee like the County) was the recipient because the Hotel Sterling is located in Wilkes-Barre. The County Did Not Properly Monitor the Project The County had no documentation in its loan files to demonstrate that it properly monitored the project. The County s monitoring procedures were weak. They focused solely on job creation. They did not include procedures for monitoring a project s progress toward completion of its objective and its compliance with HUD s and other applicable requirements. The County believed its monitoring procedures were sufficient. Regulations at 24 CFR 85.40(a) state that grantees are responsible for managing the day-to-day operations of grant- and subgrantsupported activities. Grantees must monitor grant- and subgrant-supported activities to ensure compliance with applicable Federal requirements and that performance goals are achieved. On September 6, 2006, CityVest requested an additional $2 million loan to supplement the $4 million it had already received from the County for the project. On September 21, 2006, the County s board of commissioners granted preliminary approval to increase the amount of the loan because CityVest claimed that it needed the funds to enable it to proceed with the next redevelopment steps without delay. The project budget from the amended loan agreement showed that 7

$200,000 was budgeted for land or building acquisition (see appendix E), which was no increase from the original budget included in the original loan agreement, and $500,000 was budgeted for professional and financial fees (see appendix E), which was an increase of $400,000 from the budget included in the original loan agreement. However, as of September 2006, CityVest had spent $525,000, more than two and a half times the budgeted amount, on land or building acquisition and $938,287, nearly twice as much the budgeted amount, on professional and financial fees (see appendix F). Moreover, although the project budget showed that $4 million was budgeted for construction, which was an increase of $1.5 million from the budget included in the original loan agreement, CityVest spent only $67,739 on construction costs. CityVest spent $3.2 million on demolition costs. Classifying these costs as construction costs rather than demolition costs, which is what they were, was misleading. The County should have reported the actual expense amounts to the board of commissioners and other involved parties. The County had the ability to provide this information because it drew down Block Grant funds and released them to CityVest based upon the presentation of receipts by CityVest for approved expenditures. The regulations at 24 CFR 570.209(c) state that if, after the grantee enters into a contract to provide assistance to a project, the scope or financial elements of the project change to the extent that a significant contract amendment is appropriate, the project should be reevaluated under the guidelines of 24 CFR 570.209 and the recipient s guidelines. Without complete and accurate expenditure data, decision makers and other involved parties lacked significant information on which to evaluate the future of the project. The County Did Not Ensure That Required Audits Were Performed The County did not ensure that CityVest complied with the audit requirements of Office of Management and Budget (OMB) Circular A-133 5 and its loan agreement. OMB Circular A-133 requires non-federal entities that expend $500,000 or more in Federal funds in any given fiscal year 6 to have an independent audit conducted that complies with the requirements of the circular. 7 The loan agreement and amended loan agreement reiterated these requirements. 5 Audits of States, Local Governments, and Non-Profit Organizations 6 The threshold amount for conducting an audit was increased from $300,000 to $500,000 for fiscal years ending after December 31, 2003. 7 If Federal funds expended in any fiscal year total $500,000 or more and funding is from more than one Federal program, a single audit must be conducted. If Federal funds expended in any fiscal year total $500,000 or more and are from only one Federal program, the recipient has the option to have a program-specific audit conducted. A single audit means an audit that includes both the entity s financial statements and the Federal awards. A programspecific audit means an audit of one Federal program. Generally, non-federal entities that expend less than $500,000 per year in Federal awards are exempt from Federal audit requirements for that year. 8

However, the County had no copies of these required audits in its files, although at least three audits should have been completed. The County stated that CityVest s fiscal year was September 1 to August 31. The table below shows the expenditure of loan funds by CityVest s fiscal year. CityVest fiscal year Total loan expenditures 2003 $284,657 $300,000 2004 $130,717 $500,000 2005 $311,027 $500,000 2006 $915,054 $500,000 2007 $3,690,122 $500,000 2008 $668,317 $500,000 Total $5,999,894 OMB dollar threshold for audit In addition, the loan agreements required CityVest to have program audits conducted in any fiscal year in which it expended Federal funds of less than $500,000. The agreements required the audits to be conducted annually and submitted to the Luzerne County Office of Community Development. Therefore, CityVest was required to conduct audits annually. However, the County had no copies of any of these required audits in its files. CityVest Incurred an Unreasonable and Unnecessary Expense CityVest incurred an unreasonable and unnecessary expense when it expended $303,000 in loan funds to satisfy municipal liens on a property that it purchased, which was adjacent to the Hotel Sterling. The City of Wilkes-Barre filed the municipal liens on June 20, 2005, against the former property owner for demolition work. CityVest acquired the property on March 20, 2006. On December 1, 2006, the City billed CityVest $303,000 to satisfy the liens. On March 12, 2007, the County drew down $303,000 in Block Grant funds to pay the liens. However, payment of the liens was the responsibility of the former property owner. If CityVest had paid off the liens at the time of settlement, the $303,000 should have been deducted from the sale price of the property, which is customary, but in this case, it was not because the liens were not recorded on the settlement sheet. Regulations at 2 CFR Part 225, appendix A(C)(1)(a) and (i), state that costs must be necessary and reasonable for proper and efficient performance and administration of Federal awards and be the net of all applicable credits. Regulations at 2 CFR Part 225, appendix A(C)(2), state that a cost is reasonable if in its nature and amount, it does not exceed that which would be incurred by a 9

prudent person under the circumstances prevailing at the time the decision was made to incur the cost. The question of reasonableness is particularly important when governmental units or components are predominately federally funded. In determining reasonableness of a given cost, consideration should be given to whether the cost is of a type generally recognized as ordinary and necessary for the operation of the governmental unit or the performance of the Federal award. The Project Had Not Met Its Designated National Objective CityVest has spent $6 million in Block Grant funds on the Hotel Sterling project. Ultimately, the loan agreement required CityVest to create 175 permanent fulltime-equivalent jobs, with 90 of those jobs benefiting low- and moderate-income persons. All Block Grant-assisted activities are required to meet the program s eligibility criteria found in 24 CFR 570.200 to 570.206 and one of the three national program objectives described in 24 CFR 570.208. 8 The regulations at 24 CFR 570.506(b) require the County to maintain records demonstrating that each activity meets the Block Grant program s national objective requirements. For this project, the national objective to be achieved was benefit to low- and moderate-income persons through job creation or retention activities. However, as of August 2012, the project was not complete, and no jobs had been created. The following pictures show the condition of the hotel. 8 Block Grant-assisted activities must meet one of the three national program objectives: (1) benefit low- and moderate-income persons, (2) prevent or eliminate slums or blight, and (3) meet community development needs having a particular urgency. 10

Front and side view of the hotel, May 25, 2011 Front view of the hotel, May 25, 2011 11

Rear view of the hotel, May 25, 2011 Roof of the hotel, August 11, 2011 9 9 Photographs from the November 18, 2011, edition of the Citizen s Voice 12

Interior of the hotel, August 9, 2011 9 Interior of the hotel, August 9, 2011 9 13

Roof of the hotel, August 11, 2011 9 The Project Will Not Meet Its Designated National Objective The project will not meet its designated national objective because the City of Wilkes-Barre declared the structure unsafe and now the City and the County plan to demolish the hotel. The City solicited requests for proposals for demolition and the demolition will cost about $500,000. The City requested that the County split the demolition cost with it. As a result, nearly 10 years would have passed since the County entered into its initial loan agreement with CityVest, and $6 million in Block Grant funds would have been spent on a deteriorated hotel and a project that won t meet its national program objective. HUD Questioned the Eligibility of the Project Based on Its Failure To Meet a National Objective From September 9 to October 19, 2011, HUD s Philadelphia Office of Community Planning and Development conducted a remote monitoring review of the County s open and canceled Block Grant projects. This effort was also a result of HUD Office of Inspector General (OIG) audit report 2012-PH-0001. HUD determined that the CityVest project did not meet its national objective 14

criteria and questioned whether the project would meet it in the future. Later, the Philadelphia office appealed to the HUD headquarters Office of Block Grant Assistance to determine whether this activity should be canceled from the County s Block Grant inventory and whether it should apply sanctions against the County. As of the date of this audit report, HUD headquarters had not made a decision regarding this project. Conclusion Recommendations The County did not properly evaluate and underwrite its loan to CityVest. The project won t meet its designated job creation national objective. The County lacked procedures to properly evaluate and underwrite its loan to CityVest and did not properly monitor the project. As a result, the County disbursed $6 million in Block Grant funds for a project that failed to achieve its job creation national objective. Therefore, the $6 million expended for this project was ineligible. To correct this situation, the County needs to reimburse its loan program $6 million and develop and implement comprehensive procedures for (1) evaluating and underwriting proposed projects before approving applications for business development loans, and (2) monitoring Block Grant-assisted activities. We recommend that the Director of HUD s Philadelphia Office of Community Planning and Development direct the County to 1A. Reimburse its business development loan program $5,999,894 from non- Federal funds for the ineligible expenditures related to the Hotel Sterling project. 1B. Develop and implement comprehensive procedures for evaluating and underwriting proposed projects before approving applications for business development loans. 1C. Develop and implement comprehensive procedures for effectively monitoring Block Grant-assisted activities. 15

SCOPE AND METHODOLOGY We conducted the audit from March through June 2012 at the County s office located at 54 West Union Street, Wilkes-Barre, PA, and at our office located in Philadelphia, PA. The audit covered the period January 2010 through February 2012 but was expanded when necessary to include other periods. We did not rely on any computer-processed data during the audit. To achieve our audit objective, we Obtained relevant background information. Reviewed HUD regulations at 24 CFR Part 570 regarding the Community Development Block Grant program and other applicable HUD regulations and guidance. Reviewed minutes from meetings of the County s board of commissioners and CityVest s board of directors. Reviewed the County s policies and procedures as outlined in its Business Development Loan Program Handbook related to loan applications, loan approvals, monitoring and evaluation, and closing. Interviewed relevant County staff and officials from HUD s Philadelphia Office of Community Planning and Development. Reviewed the County s business development loan portfolio. Reviewed CityVest s loan application and loan agreements. Reviewed loan fund draws totaling $6 million and the documentation supporting those expenditures. Reviewed the June 15, 2001, feasibility study for the project and other correspondence and documentation maintained in the County s files for the CityVest loan. Observed and photographed the physical condition of the Sterling Hotel. We conducted the audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objective(s). We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective. 16

INTERNAL CONTROLS Internal control is a process adopted by those charged with governance and management, designed to provide reasonable assurance about the achievement of the organization s mission, goals, and objectives with regard to Effectiveness and efficiency of operations, Reliability of financial reporting, and Compliance with applicable laws and regulations. Internal controls comprise the plans, policies, methods, and procedures used to meet the organization s mission, goals, and objectives. Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations as well as the systems for measuring, reporting, and monitoring program performance. Relevant Internal Controls Significant Deficiency We determined that the following internal controls were relevant to our audit objective: Policies and procedures that the County implemented to ensure that activities met established program objectives and requirements. Policies and procedures that the County implemented to ensure that resource use was consistent with applicable laws and regulations. We assessed the relevant controls identified above. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, the reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or efficiency of operations, (2) misstatements in financial or performance information, or (3) violations of laws and regulations on a timely basis. Based on our review, we believe that the following item is a significant deficiency: The County lacked comprehensive procedures for (1) evaluating and underwriting proposed projects before approving applications for business 17

development loans, and (2) effectively monitoring Block Grant-assisted activities. 18

APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS Recommendation number Ineligible 1/ 1A $5,999,894 1/ Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity that the auditor believes are not allowable by law; contract; or Federal, State, or local policies or regulations. 19

Appendix B AUDITEE COMMENTS AND OIG S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 Comment 2 Comment 3 Comment 4 Comment 5 20

Comment 6 Comment 7 Comment 8 Comment 9 Comment 10 Comment 11 Comment 12 Comment 13 Comment 14 Comment 17 Comment 9 21

Comment 14 Comment 15 Comment 14 Comment 16 Comment 14 Comment 9 Comment 17 Comment 14 Comment 18 Comment 19 Comment 14 Comment 20 Comment 14 Comment 21 Comment 22 Comment 16 Comment 21 Comment 11 22

Comment 23 23

24

25

26

OIG Evaluation of Auditee Comments Comment 1 Comment 2 Comment 3 Comment 4 Comment 5 Comment 6 The County s statements are unsupported. We did not audit the County s program from its inception. As part of our normal process, we included the auditee s complete written response to the draft report as an appendix in the final audit report. The audit report reflects the language from the complaint. The complaint alleged possible misappropriation of funds. The Inspector General Act of 1978 gave HUD OIG the authority to initiate, carry out and complete independent and objective audits of HUD programs and operations. We initiate audits based on information obtained from program officials, program research, complaints, congressional requests and risk assessments. These audits include performance audits, which determine whether programs are achieving the desired results or benefits in an efficient and effective manner. The Integrated Disbursement and Information System (IDIS) is the drawdown and reporting system for all of HUD s Office of Community Planning and Development (CPD) formula grant programs including the Block Grant program. The other CPD formula grant programs covered by the System are the HOME Investment Partnerships program, Emergency Shelter Grant, and Housing Opportunities for Persons with AIDS. Grantees also use the System for tracking American Recovery and Reinvestment Act of 2009 CPD programs. As a nationwide database, the System is intended to provide HUD with current information regarding CPD activities underway across the Nation, including funding data. The System is used by HUD in managing the activities of more than 1,200 HUD grantees, including urban counties and States, which use the System to plan projects and activities, draw down program funds, and report on accomplishments. HUD also uses the System to generate reports used within and outside HUD, including the public, participating jurisdictions, and Congress. Grantees are able to update, change, cancel, reopen, and increase or decrease project funding in the System without review by HUD. The County s statement is unsupported. The word properly does in fact appear in regulations applicable to the County s program, for example, in the regulations at 24 CFR 570.509 and 2 CFR Part 225. However, we used the words did not properly in the audit report to summarize and characterize our overall conclusion regarding the County s lack of evaluation, underwriting, and monitoring of its $6 million loan to CityVest. As stated in the audit report, the County was responsible for properly evaluating and underwriting its $6 million loan to CityVest. HUD regulations at 24 CFR 570.209(a) provide the County guidelines designed to provide a framework for financially underwriting and selecting Block Grant-assisted economic 27

development projects that are financially viable and will make the most effective use of Block Grant funds. The objectives of the underwriting guidelines include ensuring that project costs are reasonable; all sources of project financing are committed; the project is financially feasible; and to the extent practicable, Block Grant funds are disbursed on a pro rata basis with other finances provided to the project. However, the County s policies and procedures for evaluating and underwriting its Block Grant loans consisted solely of a single-page checklist that failed to adequately cover key HUD guidelines. HUD s underwriting guidelines recognized that different levels of review may be appropriate to take into account the size and scope of a proposed project. Although the HUD guidelines for evaluating project costs and financial requirements are not mandatory, HUD expects recipients to properly evaluate and underwrite these loans. HUD expects recipients, when they develop their own programs and underwriting criteria, to take these factors into account. Given that the $6 million loan the County made to CityVest was by far the largest loan in its business development loan portfolio, it was reasonable to expect the County to have conducted more than a cursory level of evaluation and underwriting before making the loan. Comment 7 We disagree with the County s assertion that a thorough evaluation was done. As stated in the audit report, the County approved the loan although the project lacked a plan; the County did not ensure that other project funds were committed to the project; the County did not properly assess the feasibility of the project and evaluate the project s costs; the project did not comply with HUD s jurisdiction requirements; the County did not properly monitor the project; and the County did not ensure that required audits were performed. Comment 8 Contrary to the County s assertion, it did not include a copy of the June 2001 study with its written response to the audit report. As stated in the audit report, the County alleged that a feasibility study for the project was performed in 2001 to support its evaluation of the project and its costs. The nine-page document, dated June 15, 2001, and labeled a feasibility study, contained five pages of photographs and drawings of the project site and a page providing information on the physical location of the project site and background on CityVest. Although the remaining three pages were numbered, the pages were labeled sample budget scenario for site considerations; project construction components; and soft costs and summaries. All three pages were marked DRAFT in bold letters. This nine-page document did not constitute a valid feasibility study because, as stated in its October 2002 loan application, CityVest did not know the exact future use of the Hotel Sterling. Without knowing the exact future use of the site, there were no valid, detailed project costs to be reviewed. Moreover, CityVest paid for this study. There was no evidence that the County performed an independent evaluation to assess the prospects for the project s success. It was not clear what CityVest intended to do with the loan funds. 28

Comment 9 The Office of Community Development s written evaluation to the commissioners prior to their approval of CityVest s loan application on October 16, 2002, stated that it was based upon information contained in CityVest s loan application. As stated in the audit report, we found no evidence that the County performed an independent evaluation to assess the prospects for the project s success. Comment 10 In light of the County s statement, we expect that it will be receptive to our recommendations and implement corrective actions to meet the intent of those recommendations. Comment 11 The County provided no documentation to support its statements. Since the County s business development loan program was originated with Block Grant funding the subsequent repayment of loaned funds and the interest earned on the loaned funds are considered Block Grant funds. Comment 12 The audit report stated that the County approved a loan for a project that lacked a plan. Comment 13 The audit report stated the County did not ensure that other project funds were committed to the project. Comment 14 The County provided no documentation to support these statements. Comment 15 Susquehanna Real Estate LP issued a study dated March 31, 2011, that offered options for redevelopment of the Hotel Sterling site. It stated that after a comprehensive gathering and analysis of studies, information, and plans as well as a physical review and inspection of the building, the Susquehanna team concluded that there were three possible alternative development strategies. Each was detailed and analyzed in the context of financial costs and feasibility, historic and public perspective, practicality, legal and liability issues, as well as the implementation factor - a scoring that reflects the likelihood of being able to overcome challenges in order to actually get a project going. In addition, there were critical building factors present that weighed on each alternative. Because of a rapidly deteriorating building condition, time and inertia were working against the interests of those seeking to initiate a successful redevelopment strategy. Having been open to the elements for an extended period, and with the resulting water infiltration, the building had suffered sufficient degradation to the point where a series of events such as major snow load, high wind storm, or movement of the make-shift support bracing could result in a catastrophic failure of the building or integrity of the exterior facade. Because of all of these factors, there was urgency in coming to a decision on how to move forward. Although numerous possibilities and combinations were potentially available for discussion and review, the team reduced these down to the three basic options detailed as follows: 29

1. Preservation and restoration of the existing building 2. Partial demolition with retention of the 1st and 2nd levels 3. Complete demolition and site preparation Susquehanna stated that each of these options was considered in the context of likely uses appropriate for the building and site based on the findings of the team's marketing research. Susquehanna concluded that the full demolition option represented the most rational and economic approach while preserving the opportunity to develop the site when market conditions will allow it to achieve its highest and best use. The costs of this approach to resolve the immediate issues facing the building are in the range of $1 to $2 million allowing for some site enhancement until a new major development can be implemented. The City solicited requests for proposals for demolition and the County commissioners voted on September 25, 2012, to demolish the hotel. The estimated cost of the demolition was $492,729. Comment 16 The County s statement is unsupported. The success of the new developer, the accompanying jobs to be created, and tax revenue to be generated remain to be seen. The County believed that the first developer (CityVest) would be successful revitalizing the Hotel Sterling site and after 10 years since first agreeing to loan it funds, $6 million has been spent on a project that failed to achieve its job creation national objective resulting in a deteriorated hotel that the City and County now plan to demolish. Comment 17 Contrary to the County s assertion, CityVest was a subrecipient. The regulations at 24 CFR 570.500(c) define a subrecipient as a public or private nonprofit agency, authority, or organization, or authorized for-profit entity receiving Block Grant funds from the recipient or another subrecipient to undertake activities eligible for such assistance. Comment 18 We did not make any reference to 24 CFR Part 84 in the audit report. Comment 19 As stated in the audit report, the County did not ensure that CityVest complied with the audit requirements of Office of Management and Budget (OMB) Circular A-133 and its loan agreement. OMB Circular A-133 required non-federal entities that expended $500,000 or more 10 of Federal funds in any given fiscal year to have an independent audit conducted that complied with the requirements of the circular. The loan agreement and amended loan agreement reiterated these requirements. However, the County had no copies of these required audits in its files although at least three audits should have been completed. We did not request a copy of the County s Single Audit because it would not address these requirements. Regardless, at the exit conference, we asked the County to provide any documentation that it believed we needed to consider to address any issues 10 See footnote 6. 30

presented in the draft audit report and the County provided no additional documentation. Comment 20 We disagree with the County s assertion. As stated in the audit report, CityVest incurred an unreasonable and unnecessary expense. On June 20, 2005, the City of Wilkes-Barre filed two municipal liens against the former owner of a property that CityVest acquired on March 20, 2006. The former property owner was responsible for paying the liens. If CityVest had paid off the liens at the time of settlement, the $303,000 should have been deducted from the sale price of the property, which is customary, but in this case, it was not because the liens were not recorded on the settlement sheet. Comment 21 We disagree with the County s characterization of this situation as fortunate. In our opinion, we believe the exact opposite is true. Due to its failure to properly evaluate, underwrite, and monitor its loan to CityVest, the County allowed $6 million to be spent on project that failed to achieve its job creation national objective resulting in a deteriorated hotel that now needs to be demolished. The ultimate success of redeveloping the site to create jobs for County residents has yet to be demonstrated. Comment 22 The County qualified its loan of Block Grant funds to CityVest based on an expectation that the project would create at least 80 permanent full-timeequivalent jobs benefiting low- and moderate-income persons. That has not happened nor has the expenditure of the $6 million of Block grant funds for this project resulted in the elimination of slum and blight. Rather, the County s failure to properly evaluate, underwrite, and monitor this project has contributed to the site of the Hotel Sterling being a blight in the community over the last 10 years. Comment 23 As stated in the audit report, since the project failed to achieve its job creation national objective, the $6 million expended for this project was ineligible. Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity that the auditor believes are not allowable by law; contract; or Federal, State, or local policies or regulations. 31

Appendix C PROJECT BUDGET FROM LOAN APPLICATION 32

Appendix D PROJECT BUDGET FROM LOAN AGREEMENT 33

Appendix E PROJECT BUDGET FROM AMENDED LOAN AGREEMENT 34

Appendix F CITYVEST EXPENDITURE SUMMARY Total expenditures Description Amount Percentage Demolition $3,213,714 53.6% Acquisitions $1,497,144 25.0% Real estate advisor fees $688,540 11.5% Engineering fees $302,645 5.0% Attorney fees $124,180 2.1% Insurance fees $92,281 1.5% Construction $67,739 1.1% Miscellaneous fees $13,651 0.2% Total $5,999,894 100% Expenditures as of August 31, 2006, by project budget Project budget cost description Amount expended Project budget loan agreement A1. Land or building acquisition $525,000 $200,000 A2. Construction cost to contractor $178,168 $2,500,000 A3. Professional and financial fees $938,287 $100,000 A4. Machinery and equipment $0 $1,200,000 Total $1,641,455 $4,000,000 Total expenditures compared to loan agreement project budgets Project budget cost description Amount expended Project budget - loan agreement Project budget - amended loan agreement A1. Land or building acquisition $1,497,144 $200,000 $200,000 A2. Construction cost to contractor $3,281,453 $2,500,000 $4,000,000 A3. Professional and financial fees $1,221,297 $100,000 $500,000 A4. Machinery and equipment $0 $1,200,000 $1,300,000 Total $5,999,894 $4,000,000 $6,000,000 35